It’s a bit of a mouthful, isn’t it, the BlackRock iShares JPMorgan ESG $ EM Bond UCITS ETF.

But for a fund with ESG in the title — a catch-all term for investments that meet all sorts of objectives in the environmental, social and governance arenas — it has some eyebrow-raising holdings.

About $8m of the fund’s $300m in assets is in the debt of Saudi Aramco, the world’s largest oil producer, and in bonds issued by Saudi Arabia — a country with a record of human rights violations, which was implicated in the killing of journalist Jamal Khashoggi.

It is no bad thing that investors are looking to back more socially conscious companies, and that fund managers are offering ways to do that. But the challenge of defining buzzwords leaves a lot of room for manipulation. Fund managers must do a better job of articulating exactly what qualifies for inclusion — and why.

Given that the website for the BlackRock ETF says it “excludes issuers involved in controversial sectors”, investors could be forgiven for feeling misled. And it is not an isolated example.

Vanguard’s ESG ETF, for instance, declares on its website that it does not invest in fossil fuel stocks. The Financial Times pointed out last week that, actually, it does hold many stocks deeply involved in the fossil-fuel industry, such as crude refiner Marathon Petroleum and oil services company, Schlumberger. Vanguard said it would change its marketing material (although it has yet to do so).

Elsewhere, investors in passive ESG products may be surprised to find oil giant ExxonMobil in their top holdings. But in the case of the FlexShares Stoxx US ESG Impact Index Fund, it is right there: a $1.3m holding, accounting for 2.5 per cent of the fund. “Learn how we are investing in companies that are making a positive impact on the environment, social issues, and governance,” reads the blurb beneath one of the marketing videos from the fund, run by Northern Trust.

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This raises the question: what does ESG investing actually mean?

It is an important — if difficult — question to answer, especially when building broad-based indices for funds to track. ESG-focused funds that buy US stocks have doubled in size over the past year to $11.5bn, according to data company EPFR Global. BlackRock, the biggest fund manager in the world, expects the total invested in ESG ETFs globally to surpass $400bn over the next decade.

Broadly, there are two schools of thought within passive ESG investing: exclude all problematic companies, or just the worst from each sector. With the latter option, the idea is that some companies that may not seem very ESG-friendly on the face of it might be working to get better, and that effort should be supported. Hence the appearance of so many fossil-fuel companies in ESG ETFs.

Early on in the ESG movement, this was the position of bigger, public index providers. For some, like MSCI, it is still the way things are done. For example, MSCI’s bond ratings seek to assess the strength of an issuer’s ESG credentials in comparison to companies within the same sector, rather than across all bond issuers.

Indices are then built by taking the best companies from each sector. One argument in favour of this approach is that it helps keep the returns of ESG funds close to those of broader, less constrained indices, by keeping sector weightings similar.

But this has some perverse outcomes. It is how Saudi Aramco, for example, was able to obtain a middling ESG rating for a bond sold this year. Sure, says MSCI, it is a polluting oil company backed by an oppressive regime, but there are dirtier, more dubious oil companies out there.

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Punishing certain sectors on ESG principles can be equally problematic, in part because different people have different views of what ESG means. Fossil-fuel companies, for example, can be fairly safely described as environmentally unsustainable. But what about technology companies that have low carbon emissions but have been criticised for selling users’ data? What is more important: climate change or privacy? The answer probably depends on who you are talking to. Coming up with a measurement system is difficult.

People are trying, of course. Morningstar, the Chicago-based financial services firm, announced last month that it would soon bring its assessments in line with those of Sustainalytics, another major ESG index provider 40 per cent-owned by Morningstar. Last year Sustainalytics moved to tweak its ratings so that investors could not only compare oil companies against oil companies, but also get a reasonable comparison between an oil company and a tech company.

The world of ESG is still a new one; further teething problems should be expected. But an industry based on the best of intentions needs to be careful. If fund managers pushing ESG products are going to earn the trust of investors, they need to ensure that they are above reproach in the way they sell them.

joe.rennison@ft.com



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